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No. of Recommendations: 12
For this Free Choice I decided to look at Sherwin Williams (SHW). I got started a bit late, as I was also working on my tardy AZPN analysis from the prior round, and so I didn’t really start digging in to SWH until this past weekend. It’s an old Stock Advisor pick from 2008, and my interest was piqued when I learned last week that it’s been a huge winner for the service while also one of the least followed companies. I found that intriguing and worth a look.

When I undertook this project, I knew I’d be looking at many companies that I’d have no interest in investing in, and I also knew that in some cases that’d become apparent after even a cursory glance — and, indeed, that’s been the case for some. I think that may actually be what keeps some folks from doing write-ups: they do that cursory glance and decide it’s not something they want to invest in, and call it a day. But the point of the project was to learn more about the process of analysis, not to find investments, and I think there are things to be learned even from struggling businesses.

Sherwin Williams, though, is the first company I’ve looked at during this process where I ran into something so repulsive that I simply stopped my research and wouldn’t continue. I’ll get to that shortly, but first here’s a bit about the company.

Sherwin Williams was founded in 1866 and sells paints, coatings (like Thompson’s WaterSeal), and related products. They sell to consumers and also to industry, including coatings for U.S. naval vessels (for which it won the Military Coatings Excellence Award in 2014 for their work on the USS Ronald Reagan).

The company divides its business into five segments:

Paint Stores Group: these are the actual Sherwin Williams paint stores where consumers and contractors can walk in and purchase Sherwin Williams branded paint and other accessories and supplies. There are about 4000 stores in North America, making Sherwin Williams the largest operator of speciality paint stores in N.A. These stores account for over 61% of the company’s sales.

Consumer Group: the consumer group serves two roles: first, it performs all of the R&D, manufacturing, and distribution for the other segments; and second, it also supplies brands (and private-label products) that are sold through independent retailers, like the big box stores. It accounts for nearly 13% of sales, but 66% of that are “intersegment transfers” of manufactured product, mostly to the Paint Stores Group.

Global Finishes Group: this is the industrial segment, selling things like marine coatings, automative paint and finishes, etc. It has customers in nearly 100 countries around the world, and goes to market through independent retailers, distributors, and some company-operated branches. This segment accounts for nearly 19% of sales.

Latin America Group: for some reason I don’t really understand, all of the company’s Latin American operations are sandboxed into their own segment, including things like Sherwin Williams paint stores that you would otherwise expect in the Paint Stores group. It seems like an odd way to divide up the business, and indeed the company recently did a management shake-up and put the Latin American Group and Paint Stores Group under unified management. This segment has been struggling, ostensibly because of foreign exchange and weak Latin American economies; I’m sure those are both headwinds, but I also have to wonder how much of it was simply due to artificial separation of these businesses into a separate segment under separate management. The Latin American group accounts for just under 7% of sales.

Administrative Group: this is where all the costs of headquarters are contained, as well as interest payments on debt — which also seems weird to me since you’d think you’d want to track those expenses within whatever groups are investing the capital raised from that debt. But I don’t know enough about accounting to say if this approach makes more sense or not.

So what are the company’s competitive differentiators? I would have thought that paint was a pretty commoditized product by now, and indeed the annual report states that “product quality, product innovation, breadth of product line, technical expertise, service and price determine the competitive advantage for the Paint Groups segment” (and said similar things for most of the others), also noting that the company does not make meaningful use of patents. So that sounds like a commodity product to me, but the business nevertheless appears to have done well. There’s a great post on the Stock Advisor board from a painter that perhaps lends some insight into this, noting that what he cares about most is predictable, consistent quality from a company that will take care of him if he has any problems or issues. He’s been using Sherwin Williams paints for many years, discusses how they really stepped up to address a problem he had at one point, and finishes by saying:

Sherwin Williams has kept me as a customer for 13+ years because of their competative prices, customer support, and convenience; but mainly because of the QUALITY and RELIABILITY of their products. Switching products in the painting business can be a very risky proposition, especially if you stand behind your work and rely on customer referrals as I do. I can’t imagine what Sherwin Williams would have to do to lose me as a customer, but I do know it would take an awful lot.

So that perhaps lends some insight into their competitive advantage.

At this point, things are looking pretty good (Latin America aside), but then, when reading through the Risks section of the annual report, I learned that they were involved in various lawsuits but hadn’t set aside any reserves. And then a little further down I ran across this:

A trial commenced in the Santa Clara County, California proceeding on July 15, 2013 and ended on August 22, 2013. The court entered final judgment on January 27, 2014, finding in favor of the plaintiffs and against the Company and two other defendants, and holding the Company jointly and severally liable with the other two defendants to pay $1.15 billion into a fund to abate the public nuisance. The Company has filed a notice of appeal.

Now the lawsuit itself didn’t alarm me at first: companies get sued. But the fact they’d been ordered to share $1.15 Billion in damages — over a year’s worth of operating cash flow — without setting aside any kind of reserve made me sit up and decide to research this more.

It turns out that this lawsuit is about paint containing lead. And as I researched this whole thing more, it got uglier and uglier and uglier. Leaded paint was banned for interior use in the United States in 1978, but it turns out that there was a huge scientific body of evidence dating back to the early 1900’s that clearly showed lead paint was literally killing children. Europe and other countries started banning lead paint as early as 1909. But what did paint companies do here in the United States? They fought tooth and nail against any regulation, putting their profits ahead of the welfare of children for decades despite the clear evidence of harm.

Here is an interesting article from the American Journal of Public Health published back in 2000 that I uncovered during my research (PDF):

It makes for truly incredible reading about how disgusting these companies were: lying to the public, bullying other companies, using children in their advertisements for leaded paint products, and even going so far as to sell leaded paint to unwitting toy manufacturers while assuring them it was “non-poisonous” decades after lead was known to directly cause the deaths of children.

Here’s one small excerpt from that paper, but the whole thing makes for incredible reading for anyone interested:

In 1939, the National Paint, Varnish and Lacquer Association (NPVLA), a trade group representing pigment and paint manufacturers, among others, privately acknowledged its “responsibility to the public and the protection of the industry itself with respect to the use of toxic materials in the industry’s products.” In a letter marked “CONFIDENTIAL Not for Publication,” the association informed its members that “the vital factor concerning toxic materials is to intelligently safeguard the public.”… The letter specifically pointed out that lead compounds such as white lead, red lead, litharge, and lead chromate “may be considered as toxic if they find their way into the stomach.”

The lead pigment manufacturers did not act on the NPVLA’s advice. Rather, they actively sought to promote the use of lead in general and the safety of lead for interior uses in particular. Sherwin-Williams’ logo was a can of paint poured over the entire globe, with the slogan “Cover the Earth.” The Dutch Boy logo [also now a Sherwin Williams company] of National Lead Company paints was a familiar symbol in the first half of the 20th century and was an essential part of the company’s marketing strategy for white lead. In addition to appealing to master painters, homeowners, wives, and mothers, National Lead sought to influence generations of owners by marketing directly to children. In fact, children were a prime target of the company’s advertising campaign from early on, even before the LIA [Lead Industries Association] was founded. In a promotion to paint distributors, the company advised store owners, “Do Not Forget the Children.” In the 1920s, National Lead produced “A Paint Book for Girls and Boys” titled The Dutch Boy’s Lead Party. Its cover showed the Dutch Boy, bucket and brush in hand, looking at lead soldiers, light bulbs, shoe soles, and other members of the “lead family.” The Dutch Boy also promoted the use of lead paint in schoolrooms, suggesting that summer was the best time to “get after the school trustees to have each room repainted” with “flat paint made of Dutch Boy white-lead and flatting oil.”

In any case, that was it for me. I don’t care how much money a company makes, even the thought of continuing to research this company was sickening, let alone ever considering an investment in it.


I abandoned my research, so I won’t be issuing any Ratings for this one.

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